(Bloomberg) -- Foreign investors largely ignored a rally in Brazil that pushed equity and bond markets to records. Now, it may be too late to join the party.
Foreigners pulled the equivalent of $112 million from Brazilian stocks through mid-March, extending a 2018 exodus that marked the biggest annual outflow since the global financial crisis. Yet stocks have rallied 9.4 percent this year, pushing the benchmark index above 100,000 for the first time this week. One reason foreigners missed out: Talk about a massive overhaul of the nation’s bloated pension system hasn’t yet translated into reality.
“Foreigners are skeptical and that’s totally understandable,” said Joao Braga, co-head of equities at XP Asset Management, among the nation’s top-performing fund managers. "There has been a lot of reform promises in Latin America over the past few years. But they are missing out the first legs of the rally.”
That’s left the market mostly to locals confident the government can win congressional approval for the pension reform. They’ve overlooked communication bungles, whiffs of new scandals and still sluggish economic data, sticking to a bullish call that began even before President Jair Bolsonaro was elected in October. To entice foreigners into the market, some investors are looking for stocks and bonds to correct.
“A lot of people missed the boat and are hoping for a correction,” said Deltec Asset Management’s Greg Lesko in New York who is bullish on Brazil. “Valuations are getting up there, but we are still optimistic that growth will continue to improve, driving earnings per share higher.”
Singapore’s sovereign wealth fund and Citigroup Inc., have also expressed cautious optimism about Bolsonaro’s government, citing not just the pension plans but also measures aimed at slashing bureaucracy.
For now though, data from the local exchange shows that offshore investors have kept their long positions in the U.S. dollar versus the real roughly steady around the $35 billion since January, underscoring the cautious stance.
Brazilian stocks are up 17 percent in dollar terms this year, the third best among 94 global benchmarks. The country’s sovereign dollar bonds have also been on the rally: A JPMorgan index that tracks the notes reached an all-time high on Tuesday, pushing this year’s total return to 4.4 percent.
Even the real, which may have been the least preferred asset to play the optimism as it benefits less from fiscal gains and is more vulnerable to external influences, is up this year.
Still, Edwin Gutierrez at Aberdeen Standard in London, intends to remain on the sidelines. Gutierrez, who helps oversee $735 billion, doesn’t hold Brazilian dollar bonds and recently reduced his exposure to local debt by 60 percent. He’s says he’s happy to reduce risk ahead of the “inevitable noise” that will come with the negotiations of the pension reform.
“It will take a pretty big selloff to get foreigners into the trade,” Gutierrez said. “We’ve seen the vast majority of the rally. It will still rally more assuming we get a substantive pension reform approved, but nothing like we’ve seen over the past few months.”
While some strategists still see the Ibovespa at 115,000 or 120,000 by year-end, stocks are trading at 12.4 times estimated earnings, marginally below the average of the past five years of 12.8, data compiled by Bloomberg show. Currency forecasters put the real at 3.80 by year’s end, roughly where it’s trading now.
"The current valuations already price in a fair probability of the reforms being passed, with significant downside if not," said Bradford Jones, a money manager at Sagil Asset Management in London. “We are overweight Brazil, but have reduced that overweight until we see more clarity.”
--With assistance from Julia Leite.
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